Life insurance policy lapse occurs when you stop paying premiums. A policy lapse means you lose your life insurance, so the policy won’t pay out to your beneficiaries when you die. But who is most likely to lapse in their insurance policy? A working paper published by the National Bureau of Economic Research in 2022 used regulatory records from the 30 largest life insurers between 1996 and 2020 to find out.
The researchers already knew that the lapse rate had dropped from slightly more than 7% at the start of their sample to about 5% in 2020. Using this data, they found that during the financial crisis in 2007 and 2008, people living in areas with low home prices or income growth were more at risk of lapses than others.
While previous studies have shown that more people fall during economic downturns, the researchers used proprietary data from a major U.S. life insurance company to see the background. How economics affects people is based on their policy type – term or total, duration of time. And the size of the policy — and its characteristics, including age, health status, and ZIP code. They found that households with higher health risks were more likely to lapse during recessions. Among lifelong policyholders, younger families and those with more considerable survivorship benefits are more sensitive to economic downturns. And for long life, households in low-income neighborhoods are more lapsed overall and more sensitive to economic downturns.
The implication is that younger, higher health risks living in lower-income areas may overpay for insurance due to the higher risk of lapses.
“People with high health risks should not shy away from life insurance,” said Ralph Koijen, a professor of finance at the University of Chicago Booth School of Business and a co-author of the paper. “However, they should be mindful of buying a policy they can still afford during an economic downturn.”
The article did not explore how to better design life insurance policies to protect consumers from lapses. But Koijen suggests that companies could introduce premium vacations in times of economic stress to reduce the risk of households losing coverage.
How to avoid Life insurance policy lapse
The first step is to choose a policy that you can actually afford. While having enough insurance to cover your family’s expenses is important, it doesn’t help if you can’t continue to pay premiums when the going gets tough. When buying life insurance, you can reduce your premiums by reducing the coverage or term, choosing a term policy over a perpetual one, or comparing rates with other insurance companies.
Regulators require life insurance companies to provide grace periods for late payments, which are typically 30 or 31 days from the payment due date. You’re still covered during the renewal period, but your policy will expire if you don’t pay at the end of the term, and you may owe a late fee. Read your policy carefully to understand how to get back in good standing if you miss a payment.
Here are a few other ways to avoid life insurance policy lapse:
Sign up for automatic payments: This way, you won’t have to keep track of your monthly payments. Just make sure your account always has enough to cover the payments.
Switch to annual payment schedule: Not only does this usually come with a discount, but you only have to worry about one payment per year, as long as your budget allows.
One more premium rider exemption: This waives you from paying premiums if you become disabled. (This can only be added when you first purchase the policy and may come with an additional premium.)
Reduce your insurance amount: Even after purchasing your policy, you can do this to lower your premiums.
